How inflation erodes your savings over years?

Money is a so-called stable asset and the key to your purchasing power. The role it plays is enormous and has its effect on every day life and mental peace. If you would like to make more out of your money, you have to choose an investment product which beats inflation.

Investment is the key aspect which increases your money. Many people confuse saving with investing. Saving is something which you do with intention to preserve capital for a rainy day. Investment is something done to increase/maintain purchasing power.

You can consider stocks, investment in commodities(read gold), real estate etc. Each of the investment has varying levels of returns, risks, and benefits. Of all the things that you consider, cash is king, as it does not involve risk to your capital in short term.

However, for situations where the interest rates are below the inflation rate, you bring along a lot of risk with the cash that you hold over a long term. The Rs.100 you hold will be worth less few years later.

My father used to say he bought entire Diwali crackers for family of 10 members with that Rs2. Just imagine putting Rs.2 under the pillow 40 years ago and taking it out now and try to spend. Even beggars would not take it now.

When the interest rates are higher than the inflation, leaving the amount in the savings account is an investment decision in itself. In India, savings/fixed deposit rate is usually one par with or little above inflation respectively. Sometimes even lesser depending on interest rate cycle.

Inflation

Put simply, inflation is the index that defines the rise in the prices of goods and services over a period. The measurement of inflation has several methods. Wholesale Price Index (WPI) is one of inflation index. However, the common measurement which concerns you is the Consumer Prices Index (CPI).

Another measurement that measures inflation is the Retail Prices Index (RPI). Both the indexes look at the average goods for the Indian household expenditure. It includes your milk and bread to electronic gadgets. They may further consider agency subscriptions, services, and other areas depending on their impact on the usefulness to families.

Source: www.statista.com

The price data arrives from different parts of the country. The Retail Prices Index (RPI) also includes house costs, mortgage payments, which are not existent in the CPI.

Expression of Inflation rates is usually in percentages. For example, if the inflation rises by 3%, it means that the cost of products and services that you buy increase by 3% over the last year.

Effect of inflation

Inflation has an impact on your financial planning. It not only increases the burden but also disrupts your regular investment programs. For example, if you save your money in the savings account and the interest of return is below the inflation rate, you are adding risk to the money that you are holding.

A better example is the price of the milk that you buy. If it were INR 40 for a liter in the previous year, considering inflation growing at 10%, you would shell out INR 44 in the current year and Rs 48.4 next year and so on.

When your savings account yields fewer returns on the money you save, you will buy fewer goods or services for the same amount after a few years.

With inflation increasing consistently, and the prices increases year-on-year, the little interest added to the money in the savings account erodes the value of the money that you hold.

With consumer inflation rising at more than 8% and banks offering a mere 7-9% before tax , you tend to lose more money than you truly save.

Let us say that you have INR 10,000 in your savings account. The rate of interest offered by your bank on savings is 4%. Hence, at the end of the year, you receive INR 400 as the interest. Nonetheless, considering the rate of inflation at a steady 6%, you will have a purchasing power of only INR 9,800 approx., at the year end.

Given the current consistency in the growth of inflation, the rate of interest( net of tax )offered by banks is on par or the negative side. The money that you are saving for your retirement or the holiday that you are planning is slowly eroding.

Without a proper management and investment program, you are going to lose a lot of amount and fall behind achieving your goal. In other cases, you are bound to save/work for a longer period than what you had planned earlier.

Curbing inflation is in the hands of policymakers and the decisions the government takes to control the price rise. However, you have complete control over its impact in your hands.

A way out of the negative impacts of inflation is by investing your money intelligently in stock markets, real estate, gold (remember they all have a considerable risk associated). Hence, with careful planning and thoughful investment strategy, you can minimize the losses that occur in the overall portfolio through optimization. You can choose blue chip equities, particularly those that are stable and have high utility. Invest for a minimum of 5 or 10 years to reap maximum benefits. If not, invest in quality mutual funds.

The best way to beat inflation is seeking capital growth investments and possibilities. Usually by investing in the stockmarket or real estate, you can increase the returns above the current inflation rate.

However, you have to be careful while investing in the markets, as there is every possibility for the prices to fluctuate. Therefore, you have to follow a strategy or a plan that helps you protect your investment. Ensure that your investment approach reduces your losses and yields inflation beating returns.

For instance, let us say that you invested INR 10,000 in the stock market. After one year, the investment yields a profit of 4%. Along with it, the invested company further offers 4% as a dividend. In total, you receive 8% return (4% from capital gain + 4% from dividend). Now, if you consider the inflation at 6%, you still hold a positive return of 2% on your investment.

When this compounded over long periods of time not just preserves your purchasing power but also enhances it. You must remember that mere passive index investing would have returned you 16-17% in the last decade in India.

So, remember that it is not just enough to save but to invest sensibly too. Happy investing.

About parsha

I'm Parani Dharan and my passion includes investing, finance, Gaming. I also love writing for this blog which was started initially to answer his family/friends. I've successfully tried entrepreneurship, used to work in the professional financial industry but now work for a cool IT firm out of Dubai & US.